I’m not sure if the concept of a "credit bubble" makes sense. To
me, a bubble is something speculative, where people buy in the hope and expectation
of flipping to a greater fool. Debt is being offered at ridiculously low interest
rates, to be sure, but the people buying it aren’t usually looking to flip it.
On the other hand, it’s worth at least noticing that JP Morgan’s EMBI+ index
of emerging-market bond spreads hit
an all-time high yesterday, yielding just 144 basis points over Treasury
bonds. Of course, the index now is full of countries with enormous foreign-exchange
reserves and rising creditworthiness: S&P just upgraded Brazil to one notch
below investment grade, and with a positive outlook to boot. It’s almost impossible
to imagine a situation in which a country like Brazil or Mexico or Russia would
default on its dollar-denominated bonds, as Argentina did only a few years ago.
And so it’s reasonable for an index of emerging-market sovereigns to trade tighter
than high-yield debt from the likes of Ford and Chrysler, where default is far
from unthinkable.
On the other hand, sovereigns do default, and much more frequently than the
capital markets like to think. Ecuador, for one, has a very high probability
of defaulting on its external debt if populist president Rafael Correa stays
in power — and there’s no indication of his being kicked out any time soon.
Ecuador is trading at 632 basis points over Treasuries, according to JP Morgan,
which is where the EMBI as a whole stood not too many years ago. Credit spreads
are bound to widen from these levels; the only questions are when and by how
much.